USD, EUR and Commodity Divergences

Client Talking Points

USD

Investors pushed out the dots yesterday as global growth slowing and China’s quasi-acknowledgement of economic reality pushed bets on the probability of a September lift-off back below 50% and pushed the dollar -1.1% lower on the day. With dollar correlations still strong, across durations, ↓ Dollar still = ↑ (commodity/energy) re-flation and XLE followed the currency correlation playbook gaining +1.86% and leading sector performance … but the slow-growth rotation remained equally strong with XLU up 1.8% on the session (+2.8% MTD vs SPX -0.85%). The USD is up modestly this morning and Jackson Hole – the next major currency catalyst – is, on the margin, Euro bearish. Jackson Hole = Aug 27-29th, September FOMC = Sept 17th.

EUR

We remain the EUR/USD bears. The next days will bring parliamentary votes on Greece’s 3rd bailout. Make no mistake, the top Eurocrats (Draghi & Merkel) are incentivized to plug Greece’s credit hole. Expect ‘debt relief’ in some form, but no great solution to Greece’s larger structural issues nor the flawed nature of a currency union regulating uneven economies with one monetary policy. We expect slower growth in the region from here, which should put increased pressure on Draghi to issue more QE.

COMMODITY DIVERGENCES

3-factor price signaling in the commodities complex is sending mixed signals. Relative USD correlations (near-term vs. historical norms) are tracking more positively (less negatively correlated) and price volume signals vs. USD movements are diverging across the space. Nat. Gas and RBOB Gas finished +~3-4% vs. Corn and Soybeans -5-6%, all on heavy volumes. We continue to like base metals, materials, and crude on the short side, but time and price is key. Most look oversold on a near-term duration on our screens. We would look to short on strength.

Asset Allocation

CASH

60%

US EQUITIES

4%

INTL EQUITIES

5%

COMMODITIES

0%

FIXED INCOME

24%

INTL CURRENCIES

7%

Top Long Ideas

Company

Ticker

Sector

Duration

HOLX

In an analysis of the demographics of the newly insured, Pap testing, HPV, and mammography were at the top of the list of products that would be positively impacted by the ACA. As we reach the #ACATaper stage, will HOLX take a hit to their Diagnostic segment? It is possible, in our view, but so far a minor risk. As we learned last week from a lab operator, Qiagen is likely to continue to cede their 14% HPV testing share to HOLX. So while the #ACATaper appears to be finally here, there are offsets. On a disappointing note, our 3D Tomo Tracker update for July came in at 24 facilities. Down sequentially from June, and down from a peak of 54 in May. Our forecast algorithm, which is based on these updates, remains unchanged. While 20 is low, it is probably a blip in the longer term adoption cycle.

PENN

PENN has emerged as the first domestic gaming growth story in 10 years with a new casino in Massachusetts this year and one in San Diego next year. Meanwhile, regional gaming trends have stabilized, providing near term earnings visibility and upside. Upcoming catalysts include the monthly release of State gaming revenues for July, including Massachusetts, and positive earnings revisions.

TLT

Sometimes the macro rotation and allocation playbook is relatively straightforward. As growth slows and "reflation" deflates, you want to be buying A) Long-term Bonds and B) stocks that look like bonds. Bond proxies and defensive yield consistently outperform alongside the dual deceleration in demand and prices and Utilities and REITS remain the go-to sectors for growth slowing, defensive yield exposure.

Three for the Road

TWEET OF THE DAY

QUOTE OF THE DAY

One person with passion is better than forty people merely interested.

E. M. Forster

STAT OF THE DAY

Only 1.9% of Facebook users continue to use the popular 1990s-era acronym LOL to signify their laughter in a post.

08/13/15 08:05 AM EDT

CHART OF THE DAY: Draghi's "Whatever It Takes" Willingness

Editor's Note: The excerpt and chart below are from this morning's Early Look which was written by Hedgeye analyst Matthew Hedrick. For more info on how you can become a subscriber click here.

...Draghi’s “whatever it takes” continues to spell a willingness to increase his QE purchasing program (currently structured at ~ €60 billion/month – see Chart of the Day below). Look to Jackson Hole at the end of the month (Aug. 27-29) as an opportunity for Draghi to talk down the Euro. An increase in his QE target would send the Euro falling.

Broken Euro!

“The magician and the politician have much in common: they both have to draw our attention away from what they are really doing.”

-Ben Okri

But what could the Eurocrats really be doing beyond perpetuating a political ‘crisis’ in the Eurozone?

Interestingly, according to a new Opinium poll, only 14% of Brits, 17% of Dutch and 24% of French believe that the EU countries “should continue to progress towards ever closer union” and transfer more powers to Brussels.

What does this poll suggest?

It’s another confirming signal that the Eurozone project has failed. Like it or not, the union of uneven countries (today composed of 19 member states) guided under one monetary policy is deeply flawed; and the economic, political, and cultural divides across countries is not abating. The United States of America, therefore is not an apt analogy for the Eurozone.

Back to the Global Macro Grind…

But would any Eurocrat come out and say this? Not if they want to keep their job.

A great expose on Greece’s ex finance minister, Janis Varoufakis, in The New Yorker titled in jest “The Greek Warrior” reveals from the man himself the great political chicanery between the Greek government and those of the Eurozone member states around the most recent (3rd) bailout.

Varoufakis says the 19 governments could be divided into 3 groups:

“There is a very small minority that believes in austerity, and in this program. Germany leads this minority.

A second group – Ireland, Spain, Portugal, the Baltic states — has pursued austerity programs, and now fears that Syriza, if successful, would leave those countries exposed to radical domestic opposition.

Then there’s another group, of substantial countries like Italy and France—especially France—who don’t believe in austerity. But they fear that if they side with us they will be punished. Their punishment would be austerity.”

Sound conflicted? While we won’t take Varoufakis’s word as the final one, the point we’re trying to make is getting 19 states to agree on anything is a fool’s errand. There exists so many different agenda points – the problem is Eurozone countries are often more divided than united.

You don’t have to look further than the money trail to understand who is incentivized to play in this conflicted system. One great winner is Germany. Two recent data points clearly demonstrate this reality:

A new report by the Halle Institute of Economic Research shows during the debt ‘crisis’ Germany (more than any other country) benefitted by the reduction in interest rates, namely in German bund rates declining by about 300 bps, yielding interest savings of more than €100 billion (or more than 3% of GDP) during 2010-15. A significant proportion of this debt ‘crisis’ relief is attributable specifically to the Greek ‘crisis’. In short, Germany benefitted not only greatly from the flight to safety trade during the ‘crisis’ but also the debt savings helped it maintain its “fiscally conservative” budget balance.

Germany is expected to achieve a record trade surplus of 8.1% this year (vs 7.6% in 2014), according to recent report from the German Finance Ministry. A weaker EUR and strong USD (perpetuated by the Greek ‘crisis’) has supported lower energy prices and propelled Germany’s export growth (47% of Germany’s GDP is comprised of exports!)

Stay Short the EUR/USD!

On Tuesday we recommended another short signal in the EUR/USD via the etf FXE in our Real Time Alerts.

We think there are a few guiding principles to maintain this #EuroWeakness position:

The political crisis in the Eurozone isn’t going away. Extend & Pretend policy from the Eurocrats isn’t a viable solution to fix deep sovereign ails and the flawed structure of the single monetary union. ‘Real’ solutions and compromise to Greece’s debt ‘crisis’ cannot be reached in mere days with band-aid bailout packages. Greek bailout #3 isn’t going to work, just like #2 didn’t work.

Draghi and Merkel remain poised and incentivized by a weak Euro. So follow the money! Draghi’s agenda is to will growth and inflation across the region. Germany is his best horse. A weak Euro is in Merkel’s best interest to support her country’s export powerhouse.

Draghi’s “whatever it takes” continues to spell a willingness to increase his QE purchasing program (currently structured at ~ €60 billion/month – see Chart of the Day below). Look to Jackson Hole at the end of the month (Aug. 27-29) as an opportunity for Draghi to talk down the Euro. An increase in his QE target would send the Euro falling.

Janet Yellen’s Fed is increasing looking de-facto hawkish on policy. In the last week the BOE talked down inflation (and the Pound Sterling); the BOJ remains mired in economic maladies pressuring the Yen lower; China devalued the Yuan to support its exports; and Draghi’s QE bazooka for the Eurozone remains fully loaded, with no prospect for a rate hike before the Fed. His goal of achieving a 2% inflation rate is a far out pipe dream, increasing the likelihood of more QE.

While we see growth and inflation globally continuing to slow into year end, on a relative basis the currency wars will promote winners and losers. As we originally outlined as one of our Top 3 Global Macro Themes for Q3 2015, #EuropeSlowing, we continue to like the EUR/USD as a relative loser.

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August 13, 2015

Takeaway:A whopping -$7.3 billion was yanked from domestic stock funds last week, much worse than the 2015 weekly average of -$2.9 billion.

Investment Company Institute Mutual Fund Data and ETF Money Flow:Investors continued to pull money from financial markets last week. All asset classes experienced redemptions except for international equity funds, which took in +$3.5 billion, and equity ETFs which were only slightly above break-even at +$85 million in contributions. While an exodus from domestic equity has been in progress since 2014, a newer trend of fixed income outflows has developed. So far this year, domestic equity mutual funds have lost a cumulative -$90.8 billion in withdrawals, including a massive -$7.3 billion outflow last week (the worst start to the first 31 weeks to any year this cycle running at over -$18.0 billion worse than 2012, the prior softest start to an annual period). Meanwhile, total fixed income mutual funds and ETFs have experienced negative flows in 7 of the last 9 weeks, including a -$5.0 billion outflow last week.

Investors appear to be using a significant portion of domestic equity withdrawals for their contributions to international equity funds, as international equity has experienced an almost mirror inflow of +$92.0 billion. Additionally, the chart below displays the generally inverse relationship between domestic stock outflows and international equity inflows. Our preferred proxy for these growing domestic redemptions is shorting T. Rowe Price (TROW) stock with over 60% of its assets-under-management in mutual funds (see our TROW report HERE).

In the most recent 5-day period ending August 5th, total equity mutual funds put up net outflows of -$3.8 billion, trailing the year-to-date weekly average inflow of +$36 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund contributions of +$3.5 billion and domestic stock fund withdrawals of -$7.3 billion. International equity funds have had positive flows in 48 of the last 52 weeks while domestic equity funds have had only 10 weeks of positive flows over the same time period.

Fixed income mutual funds put up net outflows of -$4.4 billion, trailing the year-to-date weekly average inflow of +$1.5 billion and the 2014 average inflow of +$929 million. The outflow was composed of tax-free or municipal bond funds withdrawals of -$106 million and taxable bond funds withdrawals of -$4.3 billion.

Equity ETFs had net subscriptions of +$85 million, trailing the year-to-date weekly average inflow of +$2.3 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net outflows of -$582 million, trailing the year-to-date weekly average inflow of +$868 million and the 2014 average inflow of +$1.0 billion.

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.

Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:

Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors continued to make significant withdrawals from the long treasury TLT ETF given worries over a possible rate hike by the Fed. The TLT lost -$365 million or -7% in redemptions last week. Meanwhile, the XLB materials ETF experienced the largest inflow last week on both a percentage and dollar basis. Investors contributed +$122 million or +5% to the XLB.

Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$1.2 billion spread for the week (-$3.8 billion of total equity outflow net of the -$5.0 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.9 billion (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$18.1 billion (negative numbers imply more positive money flow to bonds for the week.)

Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

Jonathan Casteleyn, CFA, CMT

Joshua Steiner, CFA

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